MLP Taxation in Canadian Accounts

The following post is written by Brian So, a financial advisor and blogger at www.aafsinsurance.com.

Introduction to MLPs

10380233_sMaster Limited Partnerships, or MLPs, are publicly traded investment partnerships based in the U.S. They combine the liquidity of a publicly traded company with the tax efficiency of limited partnerships. The business is structured with a general partner in charge of operations, and limited partners providing the capital. Units of the partnership represent the limited partner’s stake in the company, and are traded publicly on stock exchanges.

In order to qualify as a MLP, the partnership must derive at least 90% of their income from the energy sector, primarily oil and gas. Much like the energy income trusts, that we used to have in Canada before the tax loophole was closed in 2011, MLPs are allowed to pass their income to their unitholders without paying much tax. This distribution means that unitholders are responsible for paying taxes at their own marginal tax rates. It’s also the main reason MLPs are such a popular business structure, since the MLP is off the hook for taxes on their profit. Compared to dividends, where they are taxed once at the corporation level and again on the personal level, you can see the benefit of MLP taxation.

Another benefit from MLP is the ability to defer tax. Distributions from a MLP are split into return of capital and income. The return of capital reduces your adjusted cost base (ACB) while the income is taxable at your marginal tax rate. With the majority of distribution being return of capital, an investor only has a small amount of tax to pay on the income portion. The reduction of the investor’s ACB means that he can defer paying tax until he disposes of the units or his ACB is reduced to zero.

Canadians holding MLPs in non-registered accounts

In an earlier post I made here, I mentioned that Canadians receiving U.S. dividends are subject to a 15% withholding tax. In non-registered accounts, the tax withheld can be claimed back via the foreign tax credit when you file your tax return. The end result is that you end up with 100% of the dividend. Distributions from a MLP are subject to similar rules. You’ll also be charged a withholding tax which could be claimed back with the foreign tax credit. You can recover the full amount charged, which is 35% in the case of MLP distributions.

Canadians holding MLPs in registered accounts

You may recall from my earlier post that the withholding tax is waived if you hold the U.S. stock in a RRSP. Since you don’t receive a T5 for investments held in a RRSP, there is no way for you to claim the foreign tax credit. It would be unfair to penalize investors who were saving for retirement by means of dividend paying stocks, without allowing them to recover the withholding tax. Therefore, in the tax treaty between Canada and U.S., withholding tax from dividends is waived for retirement savings accounts, such as the RRSP.

Since the TFSA is used for many things besides a retirement savings account, withholding tax is not waived. Consequently, you must pay the withholding tax, which is unrecoverable.

The same tax treaty covering U.S. dividend paying stocks does not include MLPs. This means that distributions from a MLP will be charged the whole 35% withholding tax in both a RRSP and TFSA. This amount is unrecoverable, so think twice before putting a MLP in a registered account.

If you are intrigued by the high yield and growth of MLPs, as well as their tax benefits, consider holding them in non-registered accounts. While this post provides general information on situations involving taxation of MLPs, it is not tailored to your circumstances. Please seek a tax professional regarding your tax obligations.


Brian So is a financial advisor and blogger at www.aafsinsurance.com. His areas of expertise include retirement planning, tax savings and insurance advice. If you want to hear his thoughts about the world of personal finance, follow him on Twitter.

10 Responses to “MLP Taxation in Canadian Accounts”

  1. I was not aware that Canadians holding MLP assets in their taxable accounts have a withholding tax of 35% assessed against their distributions. That sounds too high, shouldn’t it be something like 30%? (which is still high)
    It is odd, because a large portion of MLP distributions are classified as return of capital for tax purposes, which should not make them taxable to investors until the total amount of distributions exceeds your taxable cost basis.

    Best Regards,
    Dividend Growth Investor

    Reply to this comment
    • Brian So

      Feb 24. 2014

      Hi Dividend Growth Investor,

      Unfortunately, these distributions are not covered by the tax treaty, so 35% is the amount of withholding tax charged. On top of that, it’s levied on the whole distribution, not just the income. Think about how difficult it would be to keep track of ACB and how much you can claim with the FTC.

      To say that MLP taxation in Canada is complex would be the understatement of the year.

      Reply to this comment
      • thanks for comment Brian

        There seems to be a lot of inefficiency in the MLP marketplace, because of their structure. Therefore foreign and institutional investors are preveneted from the area.

        Reply to this comment
  2. Dividenden-Sammler

    Feb 24. 2014

    Hi Ninja,

    in Germany it is not worthwhile to buy LPs and MLPs!
    The withholding tax for foreign investors is extremely high, I think 35% or 40%!

    After the deduction, the “big” dividend will be only a small dividend for German investors ;-)

    Best regards
    D-S

    Reply to this comment
  3. Dividend Ninja

    Feb 24. 2014

    Thanx D-S! For non-registered accounts, don’t you have the equivalent of a “Federal Foreign Tax Credit” in Germany?

    Cheers
    DN

    Reply to this comment
  4. Bernie

    Feb 25. 2014

    It seems to me that ETFs holding MLPs are not subject to the withholding tax if held in an RRSP. David Burrows made this comment when he was a guest on BNN Market Call Tonight and had “AMLP” as a top pick in 2012.

    Reply to this comment
  5. SlowToRealize

    Apr 17. 2014

    Hi Brian, thanks for the great article:

    I see (now) that the MLP in my TFSA is paying a huge withholding tax to the US. If I sell that equity above cost, I suppose they’ll take a slice of that gain too…

    Reply to this comment

Trackbacks/Pingbacks

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    […] The rules are slightly different with regards to distributions paid out of Master Limited Partnerships (MLPs). These distributions are not the same as dividends traditionally paid by US companies. As such, treatment of the withholding tax is not reduced by the tax treaty. Distributions are charged a withholding tax of 35% for all accounts. Although this can be recovered in non-registered accounts via the FTC, withheld amounts from MLPs in RRSPs and TFSAs will not be recoverable. More information about MLPs and their taxation can be found in MLP Taxation in Canadian Accounts. […]

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